Even before the U.S. announced tough new sanctions last week, Russia’s economy was already in trouble. After 15 years of strong growth driven by higher commodity prices, the economy is now on the edge of recession.
During the first quarter, Russian GDP grew by 0.9 percent year-on-year. Forecasts for annual growth have since slowed to 0.5 percent. Unemployment is nearly 5 percent, and inflation is over 7 percent. The country’s population is aging and money is pouring out. The price to insure against Russia defaulting on its debt is surging. Credit default swaps against China’s debt (or Brazil’s, or India’s) are much cheaper. Russia’s main stock index, the Micex, is down 7 percent since July 17.
In June, Russia’s finance minister forecast that additional restrictions on sectors of Russia’s economy would cost 0.2 percent to 0.3 percent of gross domestic product this year. That confirmed what many analysts had already suspected. As the chart below shows, economists have been sharply paring back 2014 growth forecasts since March.
A new Morgan Stanley report fleshes out the current state of things and contemplates additional damage that the latest sanctions will inflict. Russian borrowers will need to find $157 billion over the next four quarters to service their debt. Without the ability to do business in U.S. dollars under the new sanctions, Russian corporations, banks, and state-owned enterprises will have to look outside Western capital markets for loans. That money will be hard to find, says Anders Aslund, an economist and senior fellow at the Peterson Institute of International Economics. “The state banks inside Russian can compensate, and the Chinese can help for a bit, but that’s it,” says Aslund.
The sanctions come as Russian corporations, banks, and state authorities face rather large debt payments to be made over the next year. Combined, they have some $35 billion due in December alone.
On top of that, the sanctions and general uncertainty over Russia’s foreign relations will likely cause Russians to curb consumption and save more, crimping profits for businesses dependent on the domestic market. The Morgan Stanley report predicts that this combination could be enough to push Russia into recession by the end of 2014, al though rising oil prices could help offset that.
Nonetheless, the broader trend will be away from investment as companies have to apply more capital to pay down debt. “Investment has been around 21 percent of GDP when it should be about 30 percent,” says Aslund. Over the long run, this will effectively lower Russia’s potential GDP.
Roads in Russia are particularly bad. There still isn’t a full, four-lane highway running between Moscow and St. Petersburg. Traffic jams in Moscow can last hours. “The roads are a major problem,” says Aslund. ” For the last 20 years, Russia has barely increased its road investment.”
Russia still has the world’s seventh-largest economy, and it’s still the planet’s biggest oil producer. Russia is also Europe’s biggest supplier of natural gas and probably will be for some time. The U.S. is building a number of facilities to export liquified natural gas. The first won’t be finished until 2016; even then, much of the gas is contracted to go to Asia, not Europe. Plus Russia has made progress at diversifying its energy customers, having signed a big deal in May to sell gas to China.
In many ways, though, Russia’s economy still hinges on what Europe does. As Renaissance Macro Research’s Neil Dutta points out, the EU remains most exposed to Russia, with about 7 percent of all EU exports destined for the Russian market, along with 12 percent of imports coming from it. The U.S. accounts for around 1 percent of both.
Depending on whether Europe decides to impose new sanctions, the shipment of gas through Ukraine is still an issue. Bloomberg News’s coverage of last week’s sanctions announcement lays out the dispute quite clearly: Half of Ukraine’s gas comes from Russia, and half of Europe’s imported gas from Russia passes through Ukrainian pipelines. After raising the price 81 percent in April, Russia cut off gas to Ukraine on June 16. Gazprom Chief Executive Officer Alexey Miller said last month that Ukraine must pay its debt before any price talks restart. Ukraine rejects the new price and has said it can survive this winter without Russian gas by cutting consumption.